ft.com/alphaville

Reading the news reports last week, one could be excused for believing that the fate of civilisation depended on the so-called “JPY carry trade,” writes Stephen Jen, Morgan Stanley’s chief currency economist, at the Global Economic Forum. Here at FT Alphaville, we would add that George Soros, interviewed on FT.com’s View from the Top last week, also did a pretty thorough job of laying the world’s, or at least the market’s, ills at the door of the now infamous yen carry trade.

Jen explains that:

1. In his view, the role that these trades have played in global risk-reduction in the past week-and-a-half has been grossly exaggerated.
2. He has been structurally bullish on the yen, looking for the Bank of Japan to be more hawkish and volatility to increase, but ironically has been unconvinced that the latest correction in USD/JPY and EUR/JPY will be sustained. In the short term, the risks to the yen are biased to the weak side, in his view, as new yen shorts are re-established.
   

Misconception 2 - Japanese investors hold leverage interest rate-sensitive foreign currency instruments in massive amounts. This is not correct, says Jen. The figure $150bn of ‘JPY carry trades’ mentioned above is a measure of the total stock of foreign mutual fund holdings by Japanese retail investors in the form of bonds. This is big but not huge - and the size of leverage on these positions couldn’t be that big. “These Japanese outflows are more ‘non-JPY longs’ than ‘JPY shorts’,” he says, ” and do not really deserve the term ‘carry trades.’”

“There are foreign investors, especially hedge funds, who have more recently started to accumulate speculative JPY shorts in size. These are genuine JPY carry trades, i.e., they are interest rate-driven, and are financed by actual leveraged borrowing in JPY….. a violent unwind of these positions could explain the JPY rally in the last week-and-a-half. All this time, Japanese retail investors have been remarkably calm. With the exception of a few hours on Monday (March 5) morning, Japanese institutional investors were net buyers of USD/JPY, not sellers,” he writes.

The fact that the JPY rallied hard as the risky assets sold off, was a reflection of general risk reduction especially by hedge funds, he adds. The direction of causality ran from global equities to the currency markets, not the other way round.

Misconception 3 - the term ‘JPY carry trade’ is inappropriate. “I believe the use of the term is too broad and sloppy”

Misconception 4 - there is incontrovertible proof of the presence of large ‘JPY carry trades’. The data is ambiguous, he claims. “While some data that track the subscription rates by Japanese retail investors for foreign currency-denominated investment trust funds and uridashi issuances do suggest an increase in outflows starting in late 2005, official data from the MoF and the BoJ on cross-border portfolio flows don’t corroborate this at all.”

“There is somehow a popular presumption that non-Japanese citizens (Eastern Europeans in particular) have been taking out their mortgages in JPY. We have looked at this issue more closely, and found that JPY loans outside Japan are small and have been declining, not rising.”

Elsewhere, John Dizard in FTfm is also sceptical that events of the past two weeks have the carry trade as their root cause. “The hysterical nonsense published and broadcast about the Japanese yen ‘carry trade’ created an interesting opportunity for the cool-headed investor or speculator in the past couple of weeks. There is such a thing as the carry trade, but it is not as large as it has been made out to be by talking heads, nor is it the cause of the present unease in financial markets.”

So it seems that after swiftly blaming China, followed by the carry trade, it is time to point the finger elsewhere.